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MarketScreener Homepage  >  Equities  >  Nasdaq  >  RGC Resources, Inc.    RGCO

RGC RESOURCES, INC.

(RGCO)
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RGC RESOURCES : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

08/05/2020 | 12:41pm EST
Forward-Looking Statements
This report contains forward-looking statements that relate to future
transactions, events or expectations. In addition, Resources may publish
forward-looking statements relating to such matters as anticipated financial
performance, business prospects, technological developments, new products,
research and development activities, operational impacts and similar matters.
These statements are based on management's current expectations and information
available at the time of such statements and are believed to be reasonable and
are made in good faith. The Private Securities Litigation Reform Act of 1995
provides a safe harbor for forward-looking statements. In order to comply with
the terms of the safe harbor, the Company notes that a variety of factors could
cause the Company's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Company's
forward-looking statements. The risks and uncertainties that may affect the
operations, performance, development and results of the Company's business
include, but are not limited to those set forth in the following discussion and
within Item 1A "Risk Factors" in the Company's 2019 Annual Report on Form 10-K
and Item 1A of this report. All of these factors are difficult to predict and
many are beyond the Company's control. Accordingly, while the Company believes
its forward-looking statements to be reasonable, there can be no assurance that
they will approximate actual experience or that the expectations derived from
them will be realized. When used in the Company's documents or news releases,
the words, "anticipate," "believe," "intend," "plan," "estimate," "expect,"
"objective," "projection," "forecast," "budget," "assume," "indicate" or similar
words or future or conditional verbs such as "will," "would," "should," "can,"
"could" or "may" are intended to identify forward-looking statements.
Forward-looking statements reflect the Company's current expectations only as of
the date they are made. The Company assumes no duty to update these statements
should expectations change or actual results differ from current expectations
except as required by applicable laws and regulations.
The three-month and nine-month earnings presented herein should not be
considered as reflective of the Company's consolidated financial results for the
fiscal year ending September 30, 2020. The total revenues and margins realized
during the first nine months reflect higher billings due to the weather
sensitive nature of the natural gas business.
COVID-19
COVID-19 has had and continues to have a significant impact on local, state,
national and global economies. The actions taken by governments, as well as
businesses and individuals, to limit the spread of the disease has significantly
disrupted normal activities throughout the Company's service territory. While
Virginia is now in Phase 3 of its reopening plan, several of the Company's
commercial customers are still temporarily closed and/or have significantly
reduced operations. Accordingly, we believe the economic impact of actions taken
to limit the spread of the virus will last at least through calendar year end
2020.
The Company has seen a decline in natural gas consumption in most categories of
its commercial customers; however, other commercial customers have increased gas
consumption as a result of specialized business models, more than offsetting the
other declines. The Company's volume of gas delivered to residential customers
has remained relatively consistent with the prior year.
The SCC issued an order in March 2020, which has subsequently been extended to
August 31, 2020, that prohibits any utility operating in Virginia from
disconnecting utility service to customers for non-payment or applying late
payment fees to delinquent accounts. As a result, the Company expects an
increase in both customer delinquencies and bad debts. Additionally, in April
2020, the SCC issued an order granting potential relief from bad debts and other
incremental expenses, directly related to the pandemic. While the Company is
tracking these costs and will file for relief with the SCC as appropriate, the
full extent of these costs and the impact to the Company's results of operations
and financial position remains unpredictable.
The full extent to which COVID-19 will impact the Company depends on future
developments, which are highly uncertain and cannot be reasonably predicted,
including the duration, scope and severity of the pandemic, the increase or
reduction in governmental restrictions to businesses and individuals, or the
potential for a resurgence of the virus among other factors. The longer COVID-19
continues, the greater the potential negative financial effect on the Company.
Due to the nature of its operations, Resources has been deemed an essential
entity by virtue of the utility services provided through Roanoke Gas.
Management has updated and implemented its pandemic plan to ensure the
continuation of safe and reliable service to customers and to maintain the
safety of the Company's employees for the duration of this pandemic.
Additionally during this time, the Company regularly evaluates its pandemic plan
for adherence to new rules and regulations issued by the Department of Labor and
the Occupational Safety and Health Administration regarding workplace safety.
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RGC RESOURCES, INC. AND SUBSIDIARIES

Overview

Resources is an energy services company primarily engaged in the regulated sale
and distribution of natural gas to approximately 62,100 residential, commercial
and industrial customers in Roanoke, Virginia and surrounding localities through
its Roanoke Gas subsidiary.
In addition, Resources is a more than 1% investor in the MVP through its
Midstream subsidiary and provides certain unregulated services through its
Roanoke Gas subsidiary. The unregulated operations of Roanoke Gas represent less
than 2% of total revenues of Resources on an annual basis.
As a public company, Resources operates under the rules and regulations
promulgated by the SEC in regards to financial reporting matters. Historically,
Resources was considered a smaller reporting company and an accelerated filer
under the definitions of Rule 12b-2 under the Securities Exchange Act of 1934
(the "Exchange Act"), as amended. On March 12, 2020, the SEC adopted amendments
to the Exchange Act that revised the definition of an accelerated filer to
exclude entities with a public float of less than $700 million and annual
revenues under $100 million. Under the revised definitions, Resources now
qualifies as a smaller reporting company and a non-accelerated filer.
Furthermore, the non-accelerated filing status extends the deadlines for SEC
filings and removes the annual requirement of an independent auditor attestation
report on the effectiveness of the Company's internal control over financial
reporting.
The Company's utility operations are regulated by the SCC, which oversees the
terms, conditions, and rates to be charged to customers for natural gas service,
safety standards, extension of service, accounting and depreciation. The Company
is also subject to federal regulation from the Department of Transportation in
regard to the construction, operation, maintenance, safety and integrity of its
transmission and distribution pipelines. FERC regulates the prices for the
transportation and delivery of natural gas to the Company's distribution system
and underground storage services. The Company is also subject to other
regulations which are not necessarily industry specific.
Over 98% of the Company's annual revenues, excluding equity in earnings of MVP,
are derived from the sale and delivery of natural gas to Roanoke Gas customers.
The SCC authorizes the rates and fees the Company charges its customers for
these services. These rates are designed to provide the Company with the
opportunity to recover its gas and non-gas expenses and to earn a reasonable
rate of return for shareholders based on normal weather.
On October 10, 2018, Roanoke Gas filed a general rate application requesting an
annual increase in customer non-gas base rates. Roanoke Gas implemented the
non-gas rates contained in its rate application for natural gas service rendered
to customers on or after January 1, 2019. On January 24, 2020, the SCC issued
the final order on the general rate application, granting Roanoke Gas an
annualized increase in non-gas base rates of $7.25 million. The order also
directed the Company to write-down $317,000 of ESAC assets that were not subject
to recovery under the final order. In March 2020, the Company refunded $3.8
million to its customers, representing the excess revenues collected plus
interest for the difference between the final approved rates and the interim
rates billed since January 1, 2019.
In fiscal 2019, the Company completed its transition to the 21% federal
statutory income tax rate as a result of the TCJA that was signed into law in
December 2017. Between the enactment of the new tax rates and the Company's
implementation of new non-gas rates effective January 1, 2019, the Company was
recovering revenues based on a 34% federal income tax rate rather than a 21%
federal tax rate. As a result, during this period, the Company recorded a
provision for refund related to estimated excess revenues collected from
customers for the difference in non-gas rates derived under the lower federal
tax rate and the 34% rate in effect. Beginning in January 2019, Roanoke Gas
incorporated the effect of the 21% federal income tax rate with the
implementation of new non-gas base rates, as filed in its general rate
application, and began refunding the excess revenues associated with the change
in the tax rate. The refund of the excess revenues related to the reduction in
the federal income tax rate was completed in December 2019. The Company also
recorded a regulatory liability related to the excess deferred income taxes on
the regulated operations of Roanoke Gas. These excess deferred income taxes are
being refunded to customers over a 28-year period. Additional information
regarding the TCJA and non-gas base rate award is provided under the Regulatory
and Tax Reform section below.

As the Company's business is seasonal in nature, volatility in winter weather
and the commodity price of natural gas can impact the effectiveness of the
Company's rates in recovering its costs and providing a reasonable return for
its shareholders. In order to mitigate the effect of variations in weather and
the cost of natural gas, the Company has certain approved rate mechanisms in
place that help provide stability in earnings, adjust for volatility in the
price of natural gas and provide a return on increased infrastructure
investment. These mechanisms include SAVE, WNA, ICC and PGA.
The Company's non-gas base rates provide for the recovery of non-gas related
expenses and a reasonable return to shareholders. These rates are determined
based on the filing of a formal non-gas rate application with the SCC utilizing
historical and proforma information, including investment in natural gas
facilities. Generally, investments related to extending
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RGC RESOURCES, INC. AND SUBSIDIARIES


service to new customers are recovered through the non-gas base rates currently
in place, while the investment in replacing and upgrading existing
infrastructure is not recoverable until a formal rate application is filed and
approved. The SAVE Plan and Rider provides a mechanism through which the Company
recovers on a prospective basis the related depreciation and expenses and
provides a return on related qualified capital investments until such time that
a formal rate application is filed. As the Company has made significant SAVE
qualified expenditures since the last non-gas base rate increase in 2013, SAVE
Plan revenues have continued to increase each year. Upon filing the 2018 non-gas
rate application the SAVE Rider reset, effective January 2019, as the prior
revenues associated with the qualified SAVE Plan infrastructure investments were
incorporated into the new non-gas rates. Accordingly, SAVE Plan revenues
declined by approximately $508,000 for the nine-month period ended June 30, 2020
compared to the same period last year; however, SAVE Plan revenues increased by
approximately $252,000 for the corresponding three-month periods.
The WNA model reduces earnings volatility, related to weather variability in the
heating season, by providing the Company a level of earnings protection when
weather is warmer than normal and providing customers some price protection when
the weather is colder than normal. The WNA is based on a weather measurement
band around the most recent 30-year temperature average. Under the WNA, the
Company recovers from its customers the lost margin (excluding gas costs) from
the impact of weather that is warmer than normal or refunds the excess margin
earned for weather that is colder than normal. The WNA mechanism used by the
Company is based on a linear regression model that determines the value of a
single heating degree day. For the three-months ended June 30, 2020, a $504,000
reduction in revenues was recognized for the effect of weather that was
approximately 39% colder than normal. In contrast, during the same period last
year, the Company accrued $461,000 in additional revenue related to 46% warmer
weather. For the nine-months ended June 30, 2020 and 2019, weather was 9% and 3%
warmer than normal, respectively, resulting in $1.3 million and $350,000 in
additional revenue for the corresponding periods.
The most recent WNA year ended on March 31, 2020. The SCC approved the Company's
request to delay billing customers for the WNA until later in the year in order
to reduce the financial burdens on its customers during the early stages of the
COVID-19 pandemic. The Company has since received approval to bill customers
over the three-month period of July to September 2020. See the Regulatory and
Tax Reform section below for more information.
The Company also has an approved rate structure in place that mitigates the
impact of financing costs associated with its natural gas inventory. Under this
rate structure, Roanoke Gas recognizes revenue for the financing costs, or
"carrying costs," of its investment in natural gas inventory. This ICC factor
applied to the cost of inventory is based on the Company's weighted-average cost
of capital including interest rates on short-term and long-term debt and the
Company's authorized return on equity. During times of rising gas costs and
rising inventory levels, the Company recognizes ICC revenues to offset higher
financing costs associated with higher inventory balances. Conversely, during
times of decreasing gas costs and lower inventory balances, the Company
recognizes less carrying cost revenue as financing costs are lower. In addition,
ICC revenues are impacted by the changes in the weighting of the components that
are used to determine the weighted-average cost of capital. Total ICC revenues
for the three and nine month periods ended June 30, 2020 declined by
approximately 28% and 15%, respectively, from the same periods last year due to
a combination of lower average price of gas in storage balances and a reduction
in the ICC factor used in calculating these revenues.
The Company's approved billing rates include a component designed to allow for
the recovery of the cost of natural gas used by its customers. The cost of
natural gas is a pass-through cost and is independent of the non-gas base rates
of the Company. This rate component, referred to as the PGA, allows the Company
to pass along to its customers increases and decreases in natural gas costs
incurred by its regulated operations. On a quarterly basis, or more frequently
if necessary, the Company files a PGA rate adjustment request with the SCC to
adjust the gas cost component of its tariff rates depending on projected
commodity price and activity. Once administrative approval is received, the
Company adjusts the gas cost component of its rates to reflect the approved
amount. As actual costs will differ from projections used in establishing the
PGA rate, the Company will either over-recover or under-recover its actual gas
costs during the period. The difference between actual costs incurred and costs
recovered through the application of the PGA is recorded as a regulatory asset
or liability. At the end of the annual deferral period, the balance is amortized
over an ensuing 12-month period as those amounts are reflected in customer
billings.
Cyber Risk
Cyber attacks are a constant threat to businesses and individuals. The Company
remains focused on these threats and is committed to safeguarding its
information technology systems. These systems contain confidential customer,
vendor and employee information as well as important operational financial data.
There is risk associated with unauthorized access of this information with a
malicious intent to corrupt data, cause operational disruptions or compromise
information. Management continuously monitors access to these systems and
believes it has security measures in place to protect these systems from cyber
attacks and similar incidents; however, there can be no guarantee that an
incident will not occur. In the event of a cyber
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RGC RESOURCES, INC. AND SUBSIDIARIES

incident, the Company will execute its Security Incident Response Plan. The Company maintains cyber insurance to mitigate financial exposure that may result from a cyber incident.


Results of Operations
The Company's operations are affected by the cost of natural gas, as reflected
in the condensed consolidated income statements under the following line item:
cost of gas - utility. The cost of natural gas is passed through to customers at
cost, which includes commodity price, transportation, storage, injection and
withdrawal fees, with any increase or decrease offset by a correlating change in
revenue through the PGA. Accordingly, management believes that gross utility
margin, a non-GAAP financial measure defined as utility revenues less cost of
gas, is a more useful and relevant measure to analyze financial performance. The
term gross utility margin is not intended to represent or replace operating
income, the most comparable GAAP financial measure, as an indicator of operating
performance and is not necessarily comparable to similarly titled measures
reported by other companies. The following results of operations analyses will
reference gross utility margin.
Three Months Ended June 30, 2020:
Net income increased by $68,023, or 6%, for the three months ended June 30,
2020, compared to the same period last year. Quarterly performance improved due
to the earnings on the MVP investment, offset by reduced operating margin as a
result of revisions to the estimated non-gas rate refund made during the same
period last year.
The tables below reflect operating revenues, volume activity and heating
degree-days.

                                                          Three Months Ended June 30,
                                                                                                    Increase /
                                                           2020                  2019               (Decrease)            Percentage
Operating Revenues
Gas Utility                                          $  10,856,453$ 11,534,948$  (678,495)                     (6) %
Non utility                                                215,465               148,002               67,463                      46  %
Total Operating Revenues                             $  11,071,918$ 11,682,950$  (611,032)                     (5) %
Delivered Volumes
Regulated Natural Gas (DTH)
Residential and Commercial                                 949,845               760,514              189,331                      25  %
Transportation and Interruptible                         1,244,246               667,711              576,535                      86  %
Total Delivered Volumes                                  2,194,091             1,428,225              765,866                      54  %
HDD (Unofficial)                                               460                   185                  275                     149  %



Total operating revenues for the three months ended June 30, 2020, compared to
the same period last year, declined by 5% as lower natural gas commodity prices
and a revision to last year's estimated provision for refund for the non-gas
rate increase more than offset a 25% increase in residential and commercial
volumes and a 95% increase in transportation volumes. The commodity price of
natural gas decreased by 32%, more than offsetting the effect of higher
non-transporting sales volumes. The average commodity price of natural gas for
the current quarter fell to $1.70 per decatherm for the quarter compared to
$2.50 per decatherm for the same period last year. Natural gas prices are
expected to remain low due to abundant supplies and depressed demand as a result
of the economic effects from COVID-19. Total residential and commercial volumes
increased by 25% due to a 149% increase in heating degree days over the same
period last year. After adjusting both periods for the WNA, the WNA adjusted
volumes reflected a decline from the same period last year. A portion of the
decline is related to the nature of the linear regression model to calculate the
WNA adjustment, as the model assumes each heating degree day has an equal
natural gas volume impact regardless of when the heating degree day occurs. The
remainder of the difference reflects the economic effects that COVID-19 had on
natural gas sales. Transportation and interruptible volumes increased by 86%
related to one multi-fuel use industrial customer that, motivated by low natural
gas prices, transitioned to natural gas as its current primary fuel source.
Excluding this one customer, total deliveries in this category declined by
66,000 decatherms or 10%. The Company placed new non-gas base rates into effect
for natural gas service rendered on or after January 1, 2019, subject to refund.
The initial rates implemented in the prior year allocated approximately 80% of
the non-gas rate increase to the customer base charge and approximately 20% to
volumetric revenues. Based on subsequent discussions with the SCC staff, the
Company adjusted its estimated provision for refund of non-gas rates in June
2019 to reflect non-gas rates that allocated 20% of the rate increase to the
customer base charge and 80% to volumetric revenues. As a result, the 2019
fiscal third quarter reflected a larger volumetric revenue component and margin
per decatherm when compared to the current quarter, while customer base charge
reflects an overall increase over the same period last year due to the revision
in the allocation of the non-
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RGC RESOURCES, INC. AND SUBSIDIARIES


gas rate increase. SAVE Plan revenues increased by $251,951 as the rates for the
SAVE Plan reset effective January 1, 2019. Non-utility revenue increased due to
higher demand for services during the quarter.

                              Three Months Ended June 30,
                                2020               2019            Decrease        Percentage
Gross Utility Margin
  Gas Utility Revenue     $  10,856,453$ 11,534,948$ (678,495)             (6) %
  Cost of Gas - Utility       3,680,408          4,132,871         (452,463)            (11) %
  Gross Utility Margin    $   7,176,045$  7,402,077$ (226,032)             (3) %



Gross utility margins decreased from the same period last year primarily as a
result of the revised allocation of the non-gas rate increase in the prior year
third quarter, combined with lower WNA adjusted volumes and the economic impact
of COVID-19 on natural gas deliveries, more than offsetting the increase in
natural gas usage by the one transportation customer discussed above. In June
2019, the non-gas rate increase was reallocated to be consistent with the SCC
staff, resulting in an increase in volumetric revenues and a decrease in
customer base charges during the prior year. As this adjustment took into
account the six-month billing period from January 2019 through June 2019, the
allocation of 80% of the increase to volumetric sales resulted in a greater
increase in volumetric margin for the quarter than the corresponding reduction
in margin related to lower customer base charge rates. The final order issued in
January 2020, reflected an allocation consistent with the revisions made in June
2019. The WNA resulted in a reduction in margin of $503,615 during the quarter
compared to a $461,315 increase in WNA margin for the same period last year as
the weather was 39% colder than normal and 46% warmer than normal, respectively.
SAVE Plan margin increased by $251,951 as the level of qualified SAVE
infrastructure investment continues to increase since the reset of the SAVE
Plan.
The components of and the change in gas utility margin are summarized below:

                                 Three Months Ended June 30,
                                   2020                2019          Increase / (Decrease)
     Customer Base Charge    $    3,613,710$ 2,616,903       $            996,807
     Carrying Cost                   50,671            70,485                    (19,814)
     SAVE Plan                      348,434            96,483                    251,951
     Volumetric                   3,660,793         4,140,562                   (479,769)
     WNA                           (503,615)          461,315                   (964,930)
     Other Gas Revenues               6,052            16,329                    (10,277)

     Total                   $    7,176,045$ 7,402,077       $           (226,032)



Operations and maintenance expenses were nearly unchanged from the same period
last year as higher compensation costs, bad debt expense and professional
services were offset by lower regulatory asset amortizations and corporate
insurance related costs. Compensation costs increased by $80,000 primarily due
to the vesting of officer stock awards and general salary adjustments. Bad debt
expense increased by an additional $25,000 for the quarter even though gross
billings declined by 20% for the quarter and 22% for the year. The increase in
bad debt is in response to management's assessment of the continuing impact of
COVID-19 and the SCC's order to suspend disconnection of service to all
customers through August 31, 2020. Accounts receivable balances are continuing
to age and past due amounts are currently at a higher level than for the same
period last year. With the continuation of the moratorium to disconnect
customers for non-payment, bad debt reserve balances are expected to continue to
increase and be compounded by the continuing effects of COVID-19 on businesses
and individuals. Professional services increased by $55,000 due to a variety of
factors, including services related to union contract negotiations, consulting
services on benefit plans and support on project evaluations. Regulatory asset
amortization decreased by $127,000 related to prior year valuation adjustments.
Corporate insurance costs declined $59,000 due to a smaller provision to related
insurance deductibles.
General taxes increased by $32,460, or 7%, associated with higher property
taxes. Property taxes continue to increase corresponding to higher utility
property balances related to ongoing infrastructure replacement, system
reinforcements and customer growth.

Depreciation expense increased by $83,030, or 4%, on an increase in utility plant investment.

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RGC RESOURCES, INC. AND SUBSIDIARIES


Equity in earnings of unconsolidated affiliate increased by $428,381, or 55%, as
the investment in MVP continues to increase.
Other income (expense), net increased by $58,523 primarily due to the $41,000
equity portion of AFUDC and the $25,000 decrease in the non-service components
of net periodic benefit costs. In the final order on the Company's non-gas rate
increase, the SCC allowed Roanoke Gas to defer financing costs related to the
two natural gas transfer stations that will interconnect Roanoke Gas'
distribution system with MVP, for potential recovery in future rate proceedings
rather than providing a return on the investment under the approved non-gas
rates.
Interest expense increased by $60,505, or 6%, due to a 28% increase in total
average debt outstanding between quarters. The higher borrowing levels derived
from the ongoing investment in MVP and financing expenditures in support of
Roanoke Gas' capital budget are partially offset by a 14% reduction in the
weighted average interest rate and capitalization of the interest component of
AFUDC related to the two interconnect stations with the MVP.
Roanoke Gas' interest expense increased by $62,839 as total average debt
outstanding increased by $10,300,000 associated with the issuance of a
$10,000,000 unsecured note. The average interest rate decreased from 3.90% to
3.84% between periods. In addition, Roanoke Gas reduced interest expense related
to the capitalization of $14,000 for the interest portion of AFUDC. The equity
component of AFUDC is included in other income (expense), net.
Midstream's interest expense decreased by $2,334 as total average debt
outstanding increased by $14,600,000 associated with cash investments in the
MVP. However, the decline in the average interest rate from 3.69% to 2.52%
related to the reduction in the variable interest rate on Midstream's credit
facility more than offset the effect of increased debt balances.
Income tax expense increased by $56,982 corresponding to an increase in taxable
income. The effective tax rate was 24.9% and 23.2% for the three month periods
ended June 30, 2020 and 2019, respectively. Both periods included the
amortization of excess deferred taxes.
Nine Months Ended June 30, 2020:
Net income increased by $2,651,023, or 32%, for the nine months ended June 30,
2020, compared to the same period last year due to the impact of the non-gas
rate increase and the earnings on the MVP investment, more than offsetting
increases in non-gas expenses.
The tables below reflect operating revenues, volume activity and heating
degree-days.

                                                          Nine Months Ended June 30,
                                                                                                    Increase /
                                                          2020                  2019                (Decrease)             Percentage
Operating Revenues
Gas Utility                                          $ 52,757,778$ 57,630,278$  (4,872,500)                     (8) %
Non utility                                               537,324               544,378                 (7,054)                     (1) %
Total Operating Revenues                             $ 53,295,102$ 58,174,656$  (4,879,554)                     (8) %
Delivered Volumes
Regulated Natural Gas (DTH)
Residential and Commercial                              5,874,218             6,408,144               (533,926)                     (8) %
Transportation and Interruptible                        3,030,987             2,217,651                813,336                      37  %
Total Delivered Volumes                                 8,905,205             8,625,795                279,410                       3  %
HDD (Unofficial)                                            3,561                 3,790                   (229)                     (6) %



Operating revenues for the nine months ended June 30, 2020 declined from the
same period last year due to a 8% reduction in residential and commercial
volumes, lower natural gas commodity prices and reduced SAVE Plan revenue more
than offsetting the increase in non-gas rates and higher transportation volumes.
The weather sensitive residential and commercial natural gas deliveries declined
by 8%, corresponding to a 6% decline in the number of heating degree days during
the period. The average commodity price of natural gas delivered for the first
nine months of fiscal 2020 was 31% per decatherm lower than the same period last
year due to available supplies and higher storage levels from a mild winter.
SAVE Plan revenues declined by $507,974 as the SAVE Rider reset effective
January 1, 2019, and all qualifying SAVE Plan investments through December 31,
2018 were included in rate base and used to derive the new non-gas base rates.
For the first three months of fiscal 2019, SAVE Plan revenues represented a
return on an accumulation of 5 years of SAVE investment. Subsequent to January
1, 2019, the SAVE Plan investments reset and currently include only 1.5 years of
qualifying investments on which to earn a return. As the Company placed into
effect new interim non-gas base rates on January 1, 2019, revenues for the
current fiscal year reflect the
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RGC RESOURCES, INC. AND SUBSIDIARIES


non-gas rate increase for the entire period, while the estimated non-gas rate
increase was reflected in prior year revenues for the six month period beginning
January 1, 2019. Transportation and industrial volumes increased 37% due to one
multi-fuel use industrial customer increasing the use of natural gas in its
production activities during the period. The extent and duration of the
increased natural gas consumption by this customer is unknown.

                                                   Nine Months Ended June 30,
                                                                                             Increase /
                                                   2020                  2019                (Decrease)             Percentage

Gross Utility Margin

  Gas Utility Revenue                         $ 52,757,778$ 57,630,278$  (4,872,500)                     (8) %
  Cost of Gas - Utility                         20,531,211            28,810,668             (8,279,457)                    (29) %
  Gross Utility Margin                        $ 32,226,567$ 28,819,610$   3,406,957                      12  %



Gross utility margins increased from the same period last year primarily as a
result of the implementation of the non-gas base rate increase and higher WNA
revenues, partially offset by a reduction in SAVE revenues. The new non-gas base
rates were in effect for the entire fiscal 2020 period, while only in place
since January 1, 2019 for last year. As a result, customer base charge revenues
increased by $738,473, while volumetric margin increased by $1,720,869
attributable to 80% of the non-gas base rate increase being allocated to
volumetric margin, net of the effect of lower residential and commercial volumes
due to warmer weather and the effects from COVID-19. WNA margin increased by
$963,147 as weather was nearly 9% warmer than normal compared to 3% warmer than
normal for the same period last year and a full year implementation of the
non-gas base rate increase in the WNA calculation. SAVE Plan revenues declined
by $507,974 as all related SAVE investments were incorporated into the new
non-gas base rates effective January 1, 2019. The prior year also included a
reserve for excess revenues attributable to the reduction in income tax rates,
which were refunded to customers. The current year has no such adjustment as the
new non-gas rates incorporate the effect of lower federal income tax rates.
The components of and the change in gas utility margin are summarized below:

                            Nine Months Ended June 30,
                             2020               2019           Increase / (Decrease)
Customer Base Charge    $ 10,805,138$ 10,066,665       $            738,473
Carrying Cost                291,712            345,052                    (53,340)
SAVE Plan                    819,046          1,327,020                   (507,974)
Volumetric                18,898,658         17,177,789                  1,720,869
WNA                        1,313,540            350,393                    963,147
Other Gas Revenues            98,473             76,572                     21,901
Excess Revenue Refund              -           (523,881)                   523,881
Total                   $ 32,226,567$ 28,819,610       $          3,406,957



Operations and maintenance expenses increased by $791,050, or 7%, from the same
period last year related to the write-off of a portion of the ESAC regulatory
assets and increases in compensation costs, cost of professional services and
bad debt expense, partially offset by higher capitalized overheads. The final
order on the Company's non-gas rate increase directed the Company to write-down
$317,000 of ESAC assets that were not subject to recovery. The Company recorded
the valuation adjustment in December 2019. Compensation costs increased by
$294,000 primarily related to the vesting of officer stock awards. Professional
services increased by $179,000 due to a variety of factors including legal
assistance in the non-gas rate application, services related to union contract
negotiations, network systems support, benefit plan consulting and project
support activities. Bad debt expense increased by $102,000 related to COVID-19.
With the continuation of the moratorium on terminating gas service on delinquent
customers, delinquencies and corresponding bad debt expense are expected to
continue in an upward trend. Capitalized overheads increased by $110,000
primarily due to timing of LNG production related to facility upgrades at the
plant.
General taxes increased by $99,345, or 6%, primarily associated with higher
property taxes on corresponding increases in utility property balances related
to ongoing investment in the natural gas distribution facilities.

Depreciation expense increased by $248,801, or 4%, on an increase in utility property balances.

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RGC RESOURCES, INC. AND SUBSIDIARIES


Equity in earnings of unconsolidated affiliate increased by $1,449,836, or 71%,
as a result of AFUDC related to the increased investment in MVP.
Other income (expense), net increased by $286,463 primarily due to the $205,000
equity portion of AFUDC income, related to the two Roanoke Gas transfer stations
that will interconnect with the MVP, and a $76,000 decrease in the non-service
components of net periodic benefit costs. The Company recorded AFUDC based on
activity retro-active to January 1, 2019, the effective date of the new non-gas
rates.
Interest expense increased by $474,552, or 18%, due to a 29% increase in total
average debt outstanding for the periods related to the ongoing investment in
MVP and Roanoke Gas' infrastructure, partially offset by a reduction in the
weighted average interest rate during the period.
Roanoke Gas interest expense increased by $281,941 as total average debt
outstanding increased by $9,400,000 associated with debt issuance in December
2019. The average interest rate increased from 3.79% to 3.81% between periods.
The increase in interest expense was mitigated by the capitalization of $67,000
for the interest portion of AFUDC as authorized by the SCC in the final order on
the non-gas rate increase.
Midstream interest expense increased by $192,611 as total average debt
outstanding increased by $15,900,000 associated with its investment in the MVP.
The average interest rate decreased from 3.71% to 2.98% due to the decline in
the variable interest rate on Midstream's credit facility and the entry into two
separate notes with swap rates at 3.24% and 3.14%.
Income tax expense increased by $923,220, or 37%, on a corresponding increase in
taxable income. The effective tax rate was 23.9% and 23.3% for the nine months
ended June 30, 2020 and 2019, respectively.
Critical Accounting Policies and Estimates
The consolidated financial statements of Resources are prepared in accordance
with GAAP. The amounts of assets, liabilities, revenues and expenses reported in
the Company's consolidated financial statements are affected by accounting
policies, estimates and assumptions that are necessary to comply with generally
accepted accounting principles. Estimates used in the financial statements are
derived from prior experience, statistical analysis and management judgments.
Actual results may differ significantly from these estimates and assumptions.
The Company considers an estimate to be critical if it is either quantitatively
or qualitatively material to the financial statements and requires assumptions
to be made that were uncertain at the time the estimate was derived and changes
in the estimate are reasonably likely to occur from period to period. The
Company increased it provision for bad debts in anticipation of the economic
fallout expected from COVID-19. The anticipated impact on customers from the
virus and governmental restrictions, combined with the SCC orders prohibiting
customer disconnection of utility service, is expected to result in rising
customer delinquencies and higher bad debt expense, that could continue through,
at least, the remainder of the calendar year. The Company's estimated reserve
for bad debts is based on historical activity as well as the evaluation of
information currently available, including any relevant trends. Management will
continue to evaluate collectability of its receivables and revise its estimate
of bad debts as more information becomes available.
The Company adopted 2016-02, Leases, and subsequent guidance and amendments
effective October 1, 2019. The adoption of the ASU did not have a significant
effect on the Company's results of operations, financial position or cash flows
as the Company has only one lease, and management determined that the value of
the lease obligation was de minimis. The Company does have easements for
rights-of-way for its distribution system; however, all related costs associated
with these have been paid in advance with no remaining obligation.
There have been no other changes to the critical accounting policies as
reflected in the Company's Annual Report on Form 10-K for the year ended
September 30, 2019.
Asset Management
Roanoke Gas uses a third-party asset manager to manage its pipeline
transportation, storage rights and gas supply inventories and deliveries. In
return for being able to utilize the excess capacities of the transportation and
storage rights, the asset manager pays Roanoke Gas a monthly utilization fee. In
accordance with an SCC order issued in 2018, a portion of the utilization fee is
retained by the Company with the balance passed through to customers through
reduced gas costs. The current asset manager contract has been renewed through
March 31, 2022.



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RGC RESOURCES, INC. AND SUBSIDIARIES

Equity Investment in Mountain Valley Pipeline

On October 1, 2015, Midstream entered into an agreement to become a 1% member in the LLC. The purpose of the LLC is to construct and operate the MVP.


On November 19, 2019, the Company's Board of Directors approved a pro-rata
increase in its participation in MVP. As a result, Midstream's equity interest
will increase to approximately 1.03% by the time the pipeline is placed in
service and the Company's total estimated cash investment is expected to range
from $57 to $59 million.

Management believes the investment in the LLC will be beneficial for the
Company, its shareholders and southwest Virginia. In addition to Midstream's
potential returns from its investment in the LLC, Roanoke Gas will benefit from
this additional delivery source. Currently, Roanoke Gas is served by two
pipelines and an LNG peak-shaving facility. Damage to or interruption in supply
from any of these sources, especially during the winter heating season, could
have a significant impact on the Company's ability to serve its customers. This
additional capacity would reduce the impact from such an event as well as allow
the Company to better meet both current and future demands for natural gas. In
addition, the proposed pipeline path would provide the Company with a more
economically feasible opportunity to provide natural gas service to currently
unserved areas within its certificated service territory.

Total MVP project work is approximately 92% complete. Activity on the MVP has
been limited this year to maintaining the infrastructure currently in place and
restoration activities. The LLC is working to resolve pending legal and
regulatory challenges to or otherwise affecting certain aspects of the project,
including actively working with the respective regulatory bodies on the
reissuance of water crossing permits that were vacated by the Fourth Circuit as
well as the permit to cross a section of the Jefferson National Forest. Until
such time as approval is granted, activity on the pipeline will be limited as
most of the pipeline work not encompassed in the revoked permits has been
completed.

On June 11, 2020, the LLC announced that it is targeting a full in-service date
in early 2021 for the MVP project. In connection with the adjusted targeted
in-service date, it is expected that the total costs for the MVP project may
potentially increase by approximately 5% over the project's $5.4 billion budget
(excluding AFUDC) primarily due to the need to adapt to complex judicial
decisions and regulatory changes. Completion of the project in accordance with
these targets will require, among other things, timely issuance by the
Department of the Interior'sFish and Wildlife Service of a new Biological
Opinion and Incidental Take Statement for the MVP project (and resolution of
related litigation), receipt of authorizations from the Bureau of Land
Management and U.S. Forest Service and the lifting of the stop work order issued
by the FERC, and timely approval of the LLC's pending Nationwide Permit 12
permits or utilization of alternative permitting authority and/or construction
methods to cross streams and wetlands in a manner not requiring a Nationwide
Permit 12. The delays in completing the project combined with the increased
costs has reduced the expected return on investment.

Midstream entered into the Third Amendment to Credit Agreement and amended the
corresponding associated notes to increase the borrowing capacity under the
credit facility from $26 million to $41 million and extend the maturity date to
December 29, 2022. Under the amended agreement and notes, Midstream will have
the financing capacity to meet its MVP funding requirements. If the legal and
regulatory challenges are not resolved and/or restrictions are imposed by the
government related to COVID-19 that impact future construction, the cost of the
MVP and Midstream's capital contributions may increase above current estimates,
additional financing may be required, and the in-service date may be extended
beyond early 2021.

The current earnings from the MVP investment are attributable to AFUDC income
generated by the deployment of capital in the design, engineering, materials
procurement, project management and construction of the pipeline. AFUDC is an
accounting method whereby the costs of debt and equity funds used to finance
infrastructure construction are credited to income and charged to the cost of
the project. The level of investment in MVP, as well as the AFUDC, will continue
to grow as construction activities continue. When the pipeline is completed and
placed into service, AFUDC will cease. Once operational, earnings will be
derived from pipeline utilization capacity charges, per contract. It is expected
that these future earnings will be below the level of current AFUDC recognized.

In 2018, Midstream became a participant in Southgate, a project to construct a
75-mile pipeline extending from the MVP mainline at the Transco interconnect in
Virginia to delivery points in North Carolina. The FERC issued the CPCN for
Southgate in June 2020. Midstream is a less than 1% investor in the Southgate
project and, based on current estimates, will invest approximately $2.1 million
in Southgate. Midstream's participation in the Southgate project is for
investment purposes only. Subject to approval by the FERC and other regulatory
agencies, the Southgate project is targeted to be placed in-service in 2021.


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RGC RESOURCES, INC. AND SUBSIDIARIES

Regulatory and Tax Reform


On October 10, 2018, Roanoke Gas filed a general rate case application
requesting an annual increase in customer non-gas base rates. This application
incorporated into the non-gas base rates the impact of tax reform, non-SAVE
utility plant investment, increased operating costs, recovery of regulatory
assets, including all deferred ESAC related costs, and SAVE Plan investments and
related costs previously recovered through the SAVE Rider. Approximately $4.7
million of the rate increase was attributable to moving the SAVE Plan related
revenues into non-gas base rates. The new non-gas base rates were placed into
effect for gas service rendered on or after January 1, 2019, subject to refund,
pending audit by SCC staff, hearing and final order by the SCC.

Following the completion of the SCC staff audit and the issuance of the hearing
examiner's report, the SCC issued its final order on January 24, 2020. The SCC
order awarded Roanoke Gas an annualized non-gas rate increase of $7.25 million
with approximately 80% of the increase allocated to the volumetric component of
rates. The non-gas rate award provided for a 9.44% return on equity but excluded
from rates, at the current time, a return on the investment of two interconnect
stations with the MVP. In addition, the final order directed the Company to
write-off a portion of ESAC assets that were excluded from recovery under the
rate award. As a result, in the first quarter the Company expensed an additional
$317,000 of ESAC assets above the normal amortization amount. Management
submitted its rate design to reflect the increase of $7.25 million in non-gas
rates, which was approved by the SCC at the end of January 2020. The Company
completed the $3.8 million rate refund in March 2020.

As noted above, the SCC order excluded a return on investment of the two
interconnect stations currently under construction that will connect the MVP
pipeline into the Company's distribution system; however, the order did provide
for the ability to defer financing costs of these investments for future
recovery. After conferring with SCC staff regarding proper treatment, the
Company now recognizes AFUDC to capitalize both the equity and debt financing
costs incurred during the construction phases. The specific time period allowed
for the recovery of these costs has yet to be determined; therefore, the Company
has taken a conservative position and reflected only the amount of AFUDC
incurred since January 1, 2019, the rate award's effective date. If the SCC
concludes that the AFUDC applies to an earlier period, the Company will reflect
it at that time. The condensed consolidated financial statements for the
nine-month period ending June 30, 2020 include $272,000 in AFUDC income, with
$205,000 reflected in other income (expense), net and $67,000 as an offset to
interest expense.

On March 16, 2020, in response to COVID-19, the SCC issued an order applicable
to all utilities operating in Virginia to suspend disconnection of service to
all customers until May 15, 2020, which was subsequently extended to August 31,
2020. This order was effective on issuance and also prohibited utilities from
assessing late payment fees. Under this order, the Company is unable to
disconnect any customer for non-payment of their natural gas service. Therefore,
customers that would normally be disconnected for non-payment will continue
incurring costs for gas service during the moratorium, resulting in higher
potential write-offs. While management expects to experience an increase in bad
debts, due to COVID-19-related business closings and higher unemployment, the
temporary prohibition to disconnect service will cause bad debts to increase to
even higher levels. The Company has increased its provision for bad debts;
however, the potential magnitude of the combined impact from the economy and the
SCC order on bad debts continues to be uncertain. The Company supports the
decision to suspend service disconnections in light of the current economic
situation and will work with its customers in making arrangements to keep or
bring their accounts current. On April 29, 2020, the SCC issued an order
permitting regulated utilities in Virginia to defer certain incremental,
prudently incurred costs associated with the COVID-19 pandemic. Management is
evaluating this order and the potential application to the Company.

For the WNA year ended March 31, 2020, the Company accrued a total of $2.4
million for additional revenues due to warmer weather, of which $1.8 million was
attributable to the current fiscal year. According to the provisions of the
Company's WNA rate schedule, the Company submits its annual filing to the SCC
for approval of rates to collect any revenue shortfall or refund any excess
revenues, which must then be reflected in customers' bills between the months of
May and August. However, due to the uncertainty related to COVID-19, management
submitted a request to the SCC to delay the customer billing related to the WNA
revenues. The Company believed that it was in the best interest of its customers
to delay billing at that time. On April 14, 2020, the SCC issued an order
granting the Company a waiver of the terms under the WNA rate schedule. As it
became apparent that the pandemic would not end before the winter heating
season, on June 15, 2020, the Company filed a motion with the SCC requesting
that it be allowed to collect the WNA revenues beginning in July 2020 to ensure
the WNA billing would be completed before the winter heating season. On June 17,
2020, the Commission granted the Company's request and the Company began billing
the WNA revenues during the three-month period beginning July 2020 through
September 2020.

The general rate case application incorporated the effects of tax reform, which
reduced the federal tax rate for the Company from 34% to 21%. Roanoke Gas
recorded two regulatory liabilities to account for this change in the federal
tax rate. The first regulatory liability related to the excess deferred taxes
associated with the regulated operations of Roanoke Gas. As Roanoke
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RGC RESOURCES, INC. AND SUBSIDIARIES


Gas had a net deferred tax liability, the reduction in the federal tax rate
required the revaluation of these excess deferred income taxes to the 21% rate
at which the deferred taxes are expected to reverse. The excess net deferred tax
liability for Roanoke Gas' regulated operations was transferred to a regulatory
liability, while the revaluation of excess deferred taxes on the unregulated
operations of the Company were flowed into income tax expense in the first
quarter of fiscal 2018. A majority of the regulatory liability for excess
deferred taxes was attributable to accelerated tax depreciation related to
utility property. In order to comply with the IRS normalization rules, these
excess deferred income taxes must be flowed back to customers and through tax
expense based on the average remaining life of the corresponding assets, which
approximates 28 years. The corresponding balances related to the excess deferred
taxes are included in the regulatory liability schedule in Note 14 of the
condensed consolidated financial statements in Item 1 of this filing.

The second regulatory liability relates to the excess revenues collected from
customers. The non-gas base rates used since the passage of the TCJA in December
2017 through December 2018 were derived from a 34% federal tax rate. As a
result, the Company over-recovered from its customers the difference between the
federal tax rate at 34% and the 24.3% blended rate in fiscal 2018 and 21% in
fiscal 2019. To comply with an SCC directive issued in January 2018, Roanoke Gas
recorded a refund for the excess revenues collected in fiscal 2018 and the first
quarter of fiscal 2019. Starting with the implementation of the new non-gas base
rates in January 2019, Roanoke Gas began returning the excess revenues to
customers over a 12-month period. The refund of the excess revenues was
completed in December 2019.

The Company continues to recover the costs of its infrastructure replacement
program through its SAVE Plan. The original SAVE Plan was designed to facilitate
the accelerated replacement of aging natural gas pipe by providing a mechanism
for the Company to recover the related depreciation and expenses including a
return on qualifying capital investment without the filing of a non-gas base
rate application. Since the implementation and approval of the original SAVE
Plan in 2012, the Company has modified, amended or updated its SAVE Plan each
year to incorporate various qualifying projects. In May 2020, the Company filed
its most recent SAVE application with the SCC to further amend its SAVE Plan and
for approval of a SAVE Rider for the period October 2020 through September 2021.
In its application, the Company requested to continue to recover the costs of
the replacement of pre-1973 plastic pipe. In addition, the Company requested to
include the replacement of certain regulator stations and pre-1971 coated steel
pipe as qualifying SAVE projects. The 2021 SAVE Rider is designed to collect
approximately $2.3 million, an increase of approximately $1.2 million in annual
revenues above the existing SAVE Rider. The Company's SAVE Plan application also
seeks to return approximately $73,000 to customers for the over-collection in
revenues that occurred in fiscal 2019. The application is currently pending with
the SCC.
Capital Resources and Liquidity
Due to the capital intensive nature of the utility business, as well as the
related weather sensitivity, the Company's primary capital needs are the funding
of its utility plant capital projects, investment in the MVP, the seasonal
funding of its natural gas inventories and accounts receivable and the payment
of dividends. To meet these needs, the Company relies on its operating cash
flows, line-of-credit agreement, long-term debt and equity capital.
Cash and cash equivalents decreased by $430,143 for the nine-month period ended
June 30, 2020, compared to a $990,934 increase for the same period last year.
The following table summarizes the sources and uses of cash:

                                                       Nine Months Ended June 30,
                                                        2020               2019
Cash Flow Summary
Net cash provided by operating activities          $ 12,826,099$ 16,586,517
Net cash used in investing activities               (23,506,062)       

(33,296,103)

Net cash provided by financing activities            10,249,820         

17,700,520

Increase (decrease) in cash and cash equivalents $ (430,143)$ 990,934




The seasonal nature of the natural gas business causes operating cash flows to
fluctuate significantly during the year as well as from year to year. Factors,
including weather, energy prices, natural gas storage levels and customer
collections, contribute to working capital levels and related cash flows.
Generally, operating cash flows are positive during the fiscal second and third
quarters as a combination of earnings, declining storage gas levels and
collections on customer accounts all contribute to higher cash levels. During
the fiscal first and fourth quarters, operating cash flows generally decrease
due to increases in natural gas storage levels, rising customer receivable
balances and construction activity.
                                       34

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RGC RESOURCES, INC. AND SUBSIDIARIES


Cash flow from operating activities for the nine months ended June 30, 2020
decreased by $3,760,418 from the same period in the prior year. The decrease in
cash flow provided by operations was primarily driven by changes in regulatory
assets and liabilities, net of the effects of net income, accounts receivable
and accounts payable.
Changes in regulatory assets and regulatory liabilities, specifically the
accrued WNA, PGA and rate refund balances, were the primary drivers of the
period over period decrease in cash flows provided by operating activities.
Though the SCC issued its final order in January 2020, Roanoke Gas had been
billing its customers using interim billing rates since January 2019; therefore,
during this time the Company accrued an estimated rate refund for the amount due
to customers for the difference between total customer billings at interim rates
versus total customer billings at projected final rates. Following SCC approval
of final non-gas rates, Roanoke Gas issued refunds in March 2020 to all
customers that had been billed at interim rates since January 2019. During the
nine-month period ending June 30, 2019, the estimated rate refund increased by
$1.5 million thereby providing cash for operations. In contrast, the
distribution of the rate refund to customers during the current nine-month
period reduced cash available for operations by $3.8 million, resulting in a
total net reduction of cash between periods of $5.3 million. As noted in the
Regulatory and Tax Reform section above, the Company petitioned the SCC to delay
the billing of the $2.4 million WNA receivable at March 31, 2020. The related
increase in the WNA receivable balance resulted in a decrease in operating cash
of approximately $1.0 million when compared to the same nine-month period in the
prior year. The year-over-year change in the PGA resulted in a $3.0 million
decrease in cash provided by operations. At September 30, 2018, the Company's
PGA was in an under-collected, or receivable, position of approximately $0.9
million. Commodity prices continued to decrease throughout the nine-month period
ended June 30, 2019, outpacing the adjustments to the PGA factor and driving an
over-collection, or payable, position of $2.2 million at period end, which
resulted in a $3.1 million decrease in operating cash. PGA activity was less
volatile during the nine-month period ending June 30, 2020, providing an
operating cash increase of $0.1 million and netting against the $3.1 million
decrease of the prior year.
The aforementioned decreases in operating cash were partially offset by
increases generated by net income, accounts receivable and accounts payable. Net
income, net of equity in earnings and AFUDC, and depreciation contributed more
than $1.2 million in cash as compared to the same period last year. This
increase was primarily driven by the January 2019 increase in non-gas base
rates, as adjusted in January 2020 per the SCC's final order. The timing of when
the non-gas base rate increase was implemented results in the current year being
impacted for a full nine-months versus only six-months in the prior year.
Accounts receivable reflected a $0.1 million decrease during the current year
related to lower gas commodity costs, a warmer heating season, the application
of the rate refund to customer balances in March 2020 and the delay in WNA
billings. When compared to the $1.4 million increase in accounts receivable
balances during the same period of fiscal 2019, it results in an increase in
operating cash flows of $1.5 million. Accounts payable reductions, driven by
declining natural gas commodity prices, provided over $1.0 million in operating
cash period over period.
A summary of the cash provided by operations is provided below:

© Edgar Online, source Glimpses

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